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Gas crisis solution: As govt goes back on its word, Engro looks abroad

19 December, 2011

KARACHI: What does a company do if it has made a $1.1 billion leveraged bet on a fertiliser manufacturing business that relies on a government that consistently goes back on its word? For the Engro Corporation, it involves exploring the import of its feedstock from abroad, as well as the possibility that it may sell its principal product urea to Indian farmers instead of their Pakistani counterparts.

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KARACHI: What does a company do if it has made a $1.1 billion leveraged bet on a fertiliser manufacturing business that relies on a government that consistently goes back on its word? For the Engro Corporation, it involves exploring the import of its feedstock from abroad, as well as the possibility that it may sell its principal product – urea – to Indian farmers instead of their Pakistani counterparts.

“If the Pakistan farmer pays world market prices, we [Engro] can afford to produce urea using LNG [liquefied natural gas] as our feedstock,” said Asad Umar, the CEO of Engro Corporation, in an interview with Our Sources. “However, the government will probably not let us sell to them at those prices, so we can simply export our product to Haryana and Punjab in India.”

Engro owns what is currently the largest single-train urea manufacturing facility in the world, based in Daharki, Sindh. It relies on natural gas as the raw material for its production and has a sovereign guarantee issued by the government of Pakistan that the state-owned Sui Northern Gas Pipelines would provide an uninterrupted supply of 100 million cubic feet per day (mmcfd).

Despite rulings from the Sindh High Court that it must live up to its contractual obligations, SNGP has not been able to provide the gas that Engro needs, most recently informing the company on Friday morning that it would be indefinitely shutting off gas to the Dharki plant for the winter.

LNG – the alternative source

While the Engro management has been relentlessly lobbying the government to live up to its legal obligations, the company has also been pursuing alternative sources for raw material, the most prominent possibility of which is LNG.

“To me, LNG is the future,” said Khalid Subhani, the CEO of Engro Fertilizers, a subsidiary of the Engro Corporation. “It is possible to run a urea plant on coal gasification, but for the quantities of gas we need, the investment would be too high, close to $900 million.”

The conglomerate has recently set up a new subsidiary called Elengy Pakistan, which is seeking a licence to begin importing LNG. The company plans on using the technical expertise gained for its chemical storage and shipping terminal at Port Qasim – Engro Vopak – to help it run an LNG import terminal in Karachi.

Yet it is the government’s failure to make good on its sovereign guarantee that has most investors spooked, leading to a slide in Engro’s stock of about 21% over the past 12 months, compared to a 2% slide for the benchmark KSE-100 index over the same period.

“It’s a bit like the government defaulting on a treasury bond,” said one banker in Karachi who wished to remain anonymous.

Not reliant on subsidies

When the Dharki plant receives gas, the company pays $0.75 per million British thermal units (mmbtu) for the feedstock gas, a significant discount over global gas prices, which are trading at a spot rate of $3.25 per mmbtu in Monday’s trading on the New York Mercantile Exchange.

The government had offered that rate an incentive to promote investment in urea manufacturing, since the country currently imports around 20% of its annual demand.

Engro’s older plant pays about $1.20 per mmbtu, though that price was recently revised upwards by the government to $3.50 per mmbtu, after levying what is known as the Gas Infrastructure Development Cess, a 193% tax on the price that all fertiliser manufacturers must now pay on their feedstock gas.

Engro’s management insists that the subsidised gas supply is not the only reason why its business model makes sense and even goes so far as calling for a removal of the subsidy.

“Let the market set the prices for gas and then see who is competitive,” said Asad Umar. “We are willing to put our money where our mouth is. We want zero subsidies and zero tariff protection for our product.”

LNG is currently much more expensive than normal pipeline gas, currently trading at around $17 per mmbtu. Umar insists that, if the government forces Engro to acquire expensive gas, it would have no choice but to sell its final product at international prices, currently about 38% more expensive that locally produced urea, according to Naveed Tehseen, a research analyst at JS Global Capital.

Correction: An earlier version of the post misspelt “Daharki” as “Dharki”. The correction has been made.

End.


 
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